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Market Bulletin - Mood music

Figures for the fourth quarter published last week showed that the UK had the fastest-growing economy among G7 countries in 2016. Fourth-quarter growth was particularly pronounced in the services sector, which accounts for around four fifths of the UK economy – not bad for a country that, according to a broad range of forecasts, was meant to be struggling after the vote to leave the EU.

Exporters appear to be enjoying a strong tailwind from the cheaper pound, and a CBI survey published last week showed that sentiment among UK manufacturers was more positive than it had been in two years. Several retailers posted strong results, including WH Smith, although declining high street footfall was reflected in announcements of a fresh round of branch closures by a number of leading UK retail banks. Strong results at some European banks, including Spain’s Banco Santander, helped push the FTSEurofirst 300 up 1%.

Corporate earnings season in the UK presented a varied landscape, a fact reflected in the FTSE 100’s flat week – it ended down just 0.19%. Some of the largest-listed companies on the index, such as Shell and BP, will not report earnings until February, but analysts generally expect good news for both oil majors, not least due to last month’s OPEC production cuts agreement and to Donald Trump’s deregulation plans.

Among the season’s stock market detractors were Pearson, the publishing giant, and BT. The latter has yet to announce earnings, but last week it downgraded its 2016 expectations – its shares dropped 20%. Its public sector business in the UK declined in 2016, but the greater problem is an ongoing accounting scandal in Italy, which has now cost BT £530 million – three times its last estimate. BT has since revised its two-year outlook.

“Whilst this is a serious matter, the charge is one-off in nature and does not significantly alter the investment case,” said Nick Purves of RWC Partners. “More significantly perhaps, the company also said that it had seen a slowdown in demand from the UK government and large corporates, and as a result it was downgrading profit forecasts by around 5% and free cash flow forecasts by around 15%.”

Yet Purves believes the price has fallen too far, and that RWC may add to its existing position in the near future. Adrian Frost of Artemis Investment Management, who also has a position in the company, has already done so.

“The market fears that the business division could deteriorate further if the economy weakens in 2017–18 – in addition the accounting problems in Italy are a dent to management credibility and this unsettles investors,” says Frost. “We take the view that BT is a strong business with decent characteristics and returns. Whilst these events will mean a period of underperformance, in a market lacking value we think there is value here and have added a little to the position.”

Eastern divorce

Markets remained focused on politics on both sides of the Atlantic. In the UK, the Supreme Court ruled that the prime minister would require the assent of the UK parliament in order to trigger Article 50 – but not of the devolved parliaments at Holyrood, Cardiff and Stormont. Theresa May was nimble in her response, assuring the press that the Westminster vote would not prevent Article 50 being triggered by the end of March. She also vowed to publish a white paper on the government’s position. The swift policy about-turn is presumably designed to ensure the bill’s quick passage – both houses could yet create delays, however.

While the economic news offered Theresa May a tailwind, rumblings in the banking sector last week did not. Citigroup, it emerged, is in talks with Ireland, Italy, France, Spain, Germany and the Netherlands over where it will move its European base once the UK (where it employs 9,000 staff) leaves the EU – last week a Dublin audience was told a decision would be made by the end of June. Barclays, meanwhile, confirmed last week that Dublin would host its new EU headquarters.

A report published last week by the Institute for Government concluded that civil service departments would struggle with administering the UK’s EU exit due to losing 19% of their staff since 2010 – and due to ministers refusing to put existing projects on hold. Some of the heaviest job cuts have been in departments most affected – DEFRA has lost a third of its staff since 2010 but 80% of its work is ‘framed’ by EU law.

Western courtship

The mood music was very different in the other direction. While Theresa May faces tricky EU departure negotiations in the months ahead, last week she set her face towards America, becoming the first foreign leader to make a state visit to Donald Trump. The US president had already said he hoped the prime minister would be “my Maggie” (to his Ronald Reagan), and has expressed his eagerness to cut a quick trade deal with the UK, even as he cancels others. Theresa May, who arrived in Washington DC on Friday, said that the election of Donald Trump was a moment of “renewal” for the US, and that she hoped that the US and UK could now “lead the world together”. Her enthusiasm remains rare among high-profile global leaders, who have generally (Vladimir Putin and Kim Jong-un excepted) responded to Donald Trump’s victory with a mix of silence, polite congratulations, or criticism.

Donald Trump’s first full week in office was nothing if not decisive – executive orders abounded. The new president cancelled US involvement in the Trans-Pacific Partnership, ordered the construction of a wall on the Mexican border (using US-manufactured steel), threatened to punish companies for moving production abroad, defended the use of some forms of torture in his first press interview, and banned travellers from seven specified countries entering the US – on Monday this week, stocks appeared to be dipping in response. For many investors, however, it is his trade plans that loom largest.

“Tariffs on the likes of Chinese-manufactured textiles, shoes and autos would no doubt be politically popular in America, but from an economic viewpoint would perhaps be more symbolic than real as low-end manufacturing is already leaving China (to the likes of Vietnam), as the country moves up the value curve,” said a First State Stewart Asia (FSSA) report released last week.

FSSA remains sceptical about Hong Kong-listed manufacturing companies based in mainland China, and believes that textile companies look particularly vulnerable. “A broader move, say against the technology industry, would be much more significant and damaging… but it is hard to countenance the introduction of such measures… We assume that neither country [neither the US nor China] will be able to stomach a breakdown in such a symbiotic relationship.”

US stocks performed strongly, and the S&P 500 ended up 0.99%. The dollar also remained strong, helping the Nikkei 225 up 1.7%. However, news on Friday that the US economy had grown by 1.9% in the fourth quarter – against the 2.2% expected – dulled enthusiasm. The US’s 2016 growth rate was its lowest in five years.

Among indices, the headline event of the week was that the Dow Jones Industrial Average, a much older index comprising just 30 large companies, reached 20,000 points for the first time in its history. Traders at the New York Stock Exchange celebrated by donning baseball caps labelled “Dow 20,000”. The landmark is only a symbol, but such symbols matter on markets. The Dow Jones has risen more than 9% since Donald Trump’s victory, helped by its stakes in banks and industrials – Goldman Sachs has risen some 30% since the election.

Artemis Investment Management, First State Stewart Asia and RWC Partners are fund managers for St. James’s Place.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

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